The journey to becoming a publicly-limited company from a private company is a long and complex one. It involves various entities ranging from an investment bank to a registrar. The process of an IPO starts with the filing of the draft red herring prospectus with the Securities and Exchange Board of India and ends with the listing of the shares. In the last three financial years, around 85 companies went public in India.
Different types of IPO
An IPO can be conducted in different ways, even though the final result remains the same. There are two major types of IPOs—fixed-price method and the book building method.
The major difference between both the methods of IPO is the price at which the shares are offered to the public. In the fixed-price method, the price at which shares will be issued and allotted to investors is declared in advance by the company. In the fixed-price method, the demand for shares during the IPO is known after the closure of the issue. It simply means, the data about the number of retail, HNI or institutional investors applying for the IPO is not given out on a daily basis and is only available after the issue closes. In India, half of the shares offered through the fixed-price method are reserved for retail investors.
Book building method
The major difference between the fixed-price method and the book building mechanism is the process to determine the issue price of the IPO. Unlike the fixed-price method, the IPO price is not announced in advance. The issue price is discovered during the IPO process. The company announces a price band and investors have to bid for shares in multiples of lots at a price within the price band. Just like a fixed-price issue, half of the shares on offer are reserved for retail investors in the book building method. To maintain transparency during the book-building process, the data of subscribers is given on a daily basis.
The process of book building
The process for an IPO through the book building method starts with the appointment of the lead investment banker. conduct due diligence and advise the company on the size of the issue and the price band. If the company accepts the suggestion, the price band for the issue is declared with the prospectus. The upper limit of the price band is known as the ceiling price and the lower limit is known as the floor price.
Bidding: After the declaration of the price band, investors are invited to bid for the shares on offer. IPOs generally open for three days in India and investors can put in their bids during the specified days. Investors have to bid with the number of shares they intend to buy at varying price points.
With the closure of the IPO, the investment bankers initiate the process of price discovery. Since no fixed price is announced, there are various bids at different prices. Bankers decide the final price through a weighted average of all the bids received. The final price that is decided is known as the cut-off price. In the case of popular issues that attract bids in excess of the shares on offer, the cut-off price is often the ceiling price.
Publicity: During the IPO, companies are required to make public all the details of the bids that are received on a daily basis. The subscriber data is publicly available, which makes it easier to verify the cut-off price.
Settlement: After the announcement of the cut-off price, the registrars and the investment bankers of the issue have to settle the bids and complete the allotment. People who had bid at prices above the cut-off rate get a refund of the balance amount. If you are not sure of the cut-off price, you can opt for the ‘cut-off’ option in the application process. Opting for the cut-off option denotes that you are willing to buy the shares at the cut-off price that is decided. Generally, you have to bid at the ceiling price while opting for the cut-off option.
The fixed-price method was the dominant process for IPOs earlier, but all major companies opt for the book building method now. The book-building method provides ample flexibility to the investors as well as the investment bankers, which has led to its popularity.